Food prices, food price volatility and the financialization of agricultural futures markets Christopher L. Gilbert SAIS Bologna Center, Johns Hopkins University christopher.gilbert@jhu.edu OCP Policy Centre Workshop, “Commodity market instability and asymmetries and development policies”, Paris, 26 June 2015 1
Instruments: futures • Very many of the primary commodities traded between developing and developed countries are traded on futures markets – cocoa, coffee, sugar, crude oil, copper, rubber. • Prices for commercial transactions are generally based off (nearby) futures market prices – “pricing at unknown”. • Futures markets perform two functions 1. Price discovery: The futures price comes to incorporate all available information. 2. Risk transfer: Producers and stockholders (“commercials”) can transfer their exposure to price changes to financial agents (“non-commercials”, “speculators”) who hope to make money by taking on this risk.
Instruments: options • A producers or stockholder who sells a future gains price certainty. He is hedged. • Relative to the unhedged position, he loses money if the price rises but gains if it falls. • Options give one-sided protection. A “put” gives the producer or stockholder a guaranteed floor but allows him to gain from upside movements. A “call” gives a purchaser a price ceiling. • Options have a cost – like purchasing insurance. Futures do not imply any initial cost.
Instruments: swaps • Futures and options are traded on exchanges and have relatively small nominal value – typically $20,000 - $50,000. • Swaps are much larger transactions - $1m and upward – and so are traded between large financial actors. • In a “plain vanilla” robusta coffee swap, I pay $1m (say) to a bank and broker and obtain back $1m multiplied by the relativity of the robusta coffee futures price at contract expiration to its current value. If coffee prices have risen by 20%, I get $1.2m.
Financialization: the major increase in the presence of financial agents on food commodity futures markets. Total Commodity Futures and Swap Positions Source: Gilbert and Pfuderer (2014, Table 1) $bn Nominal 2005 values based on BIS statistics. 1998 137.8 246.6 Figures relate to the end of 2000 159.3 234.1 June. The reported figures 2002 271.5 438.4 are for total forwards and swaps and exclude gold 2004 480.7 580.5 and other precious metals. 2006 2153.4 1709.7 Column 2 deflates by the 2008 7474.2 3626.4 average of the IMF non- 2010 1470.1 1015.6 fuel commodity price and 2012 1595.9 942.1 energy price indices (2005 = 100.) 5
Do these instruments help developing countries? • We need to distinguish between governments, intermediaries and producers (farmers). • Governments of exporting countries can hedge export revenues, and will generally do so using swaps. Mexico is notable in hedging its crude oil revenues. This makes a lot of sense if the government budget is highly dependent on the price-sensitive taxes. Governments of importing countries can do the same in relation to food • import bills. • Supply chain intermediaries benefit by hedging since they work on narrow margins. By hedging they can offer finer prices since they face less risk. Hedging should therefore lower intermediation costs. • But … indigenous intermediaries will have difficulty obtaining the dollar finance to give them access to futures or options and may even not be legally allowed to undertake such actions. This gives multilaterals (or intermediaries linked to multilaterals a competitive advantage.
Farmers • Even in the developed countries, only the largest farmers directly access futures and other markets. • It is possible for buyers to pass some price protection through to farmers by, for example, offering a guaranteed floor but that the expense of offering a less attractive price in other circumstances. • Contract enforcement is a major problem. A coffee farmer will be happy to take the guaranteed floor price if prices fall but will be tempted to ignore his contractual commitments and sell to the best buyer if the market is good.
Can financialization introduce distortions? • Commercial (industry-based) traders complain that the commodity markets have been invaded by non-commercial financial firms who have little knowledge of actual market conditions. • Many politicians lament that the activities of these financial actors can take prices away from their fundamental values. • Some economists complain that financialized commodity markets tend to generate speculative bubbles. Was the oil price rise in 2007-08 a bubble? And similarly the grains price spike in 2008?
Index investors and the commodity asset class • Index-based investors have been Index investors Traditional a major concern. Index investors speculators invest in a portfolio of commodity Hold all Hold selected futures aiming to track the commodities in commodities returns on one or other major the index tradable commodity futures price index. Almost always May be long or • They claim to be motivated by long short portfolio diversification concerns Long holding Short holding and regard commodity futures as periods periods an asset class similar to equities, bonds and real estate. Roll as contracts Seldom roll • They trade in a very different way approach from traditional non-commercials expiration (“speculators”). 9
Did index trading move commodity futures prices? In US Senate testimony, hedge fund manager Michael Masters argued that they were driving commodity prices in 2008: “You have asked the question are Institutional Investors contributing to food and energy price inflation? And my unequivocal answer is YES”. The current academic consensus He added that they “eat” (Irwin, Sanders, Stoll , Whaley), is rather than provide liquidity index investors had a negligible suggesting that they would impact on agricultural futures tend to increase volatility. prices. I have taken a different view. 10
Index weights Softs, 2.6% Livestock, 3.5% The two major tradable commodity price Grains & vegetable oils, indices give a relatively low weight to 9.9% agricultural futures. Precious metals, 1.8% These weights change over time: Non-ferrous metals, 6.5% � In September 2008, the S&P GSCI index (top) gave grains and oilseeds Energy, 75.6% a 10% weight; Livestock, 7.4% � the Dow Jones UBS index gave Softs, 8.7% them a 21% weight. Energy, 33.0% This suggests that the impact of index Grains & vegetable oils, trading is likely to be more apparent in 20.8% energy futures (76% and 33% respectively). Precious Non-ferrous metals, 10.1% metals, 20.0% 11
250 200 January 2006 = 100 150 100 The 2006-08 run-up in index investment and the summer 2008 50 peak correspond very closely with the sharp rise in oil and food prices, 0 COT US agricultural futures contracts 12
Conclusions 1. Financial instruments can offer governments and supply chain intermediaries the possibility of reducing price exposure. This will increase the efficiency of the supply chain. 2. This gives intermediaries connected with multilaterals a competitive advantage relative to domestic intermediaries. 3. Developing country farmers are seldom able to benefit directly from these instruments. 4. Financialization can also introduce speculative noise into commodity prices. It sometimes moves prices away from fundamental values. 5. My view is that index investment amplified price movements in foods, metals and crude oil in 2007-08.
Thank you for your attention 14
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